As I predicted
This morning I read a post by noted MMTer Stephanie Kelton, which responded to some questions by Paul Krugman. I predicted that he’d be pulling out his hair, as her responses were a complete mess—as if she didn’t understand the simple questions he was asking. Here’s an excerpt from my Econlog post:
I can’t even imagine Krugman’s reaction to all this. First of all, although she says “no” in answer to question #1, her explanation makes it quite clear that she is actually answering “yes”, especially when you combine the answers to questions #1 and #2. Krugman is asking whether, assuming a given macroeconomic situation (including a given level of private spending), there is only one budget deficit consistent with full employment. She clearly thinks the answer is yes. So why does she answer “no”. I suspect she doesn’t understand Krugman’s question (which is pretty straightforward.)
Now Krugman has responded and he’s every bit as frustrated as I expected. Here is his response to the first point I raised:
Her response to my first question totally misses the point; I was asking if *given private behavior* there’s a unique level of the deficit needed for full employment, and argued that there wasn’t. She just assumes that there is
And here’s how Krugman summarizes his twitter thread:
Sorry, but this is just a mess. Kelton’s response misrepresents standard macroeconomics, my own views, the effects of interest rates, and the process of money creation. Otherwise I guess it’s all fine. See what I mean about Calvinball? 6/
MMT desperately needs a spokesperson capable of conversing with economists like Paul Krugman, if they want to be taken seriously. When they give bizarre answers to serious questions from a highly respected economist on their side of the ideological spectrum, it’s a problem.
Not surprisingly, I think it’s perfectly fine to be heterodox, but first you need to understand orthodox.
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1. March 2019 at 18:00
True, true.
On the other hand, Martin Feldstein, with every possible credential a macroeconomist would want, has been predicting higher interest rates and inflation for at least 10 years straight, usually in ominous tones.
I happen to think the MMT crowd is missing the point. Why should the federal government borrow money when it can print money?
Or if the federal government must by law borrow money, surely there is no problem in offsetting the borrowing by buying it back through a central bank, a process known as QE.
If QE is inflationary, we have a difficult story to tell in the entire continent of Europe or in the world’s second-largest economy Japan. If QE resulted in inflation in the United States, you would need a magnifying glass to find it.
Yes, the MMT crowd is curious, as are the Neo-Fisherians. Perhaps the problem is that people start with an agenda, that is, they are liberal or conservative, and they work back from that agenda the sort of macroeconomic fantasy they wish to entertain.
But should conventional macroeconomists stand tall… Well, let us just ask, “Is the pot calling the kettle black?“
1. March 2019 at 18:36
The worst part is that she assumes IS-LM is incompatible with Keynesian Animal Spirits:
“Krugman’s framework treats investment as a simple function of the interest rate. Higher rates mean lower investment, and vice versa. Central banks can juice (or slow) the economy simply by lowering (or raising) interest rates. It’s Pavlovian in its simplicity: stimulus-response.
Keynes’s analysis was more nuanced. Investment decisions were forward-looking, heavily influenced by “animal spirits,” and overwhelmingly dependent on the state of profit expectations. When the profit outlook is sufficiently grim, no amount of rate cutting will entice businesses to borrow and invest in new plant and equipment (think Great Recession).”
I don’t understand her argument here. An increase in profit expectations which leads to an increase in investment means a rightward shift in the IS curve. I don’t think Krugman (or any Keynesian, mainstream or heterodox) would disagree with the notion that “When the profit outlook is sufficiently grim, no amount of rate cutting will entice businesses to borrow and invest.”
1. March 2019 at 18:51
Civillyfree. You said:
“I don’t understand her argument here. An increase in profit expectations which leads to an increase in investment means a rightward shift in the IS curve. I don’t think Krugman (or any Keynesian, mainstream or heterodox) would disagree with the notion that “When the profit outlook is sufficiently grim, no amount of rate cutting will entice businesses to borrow and invest.””
Yes, you are correct. And it’s even worse. She assumes that monetary policy works by encouraging borrowing. It doesn’t, it works by boosting NGDP through the hot potato effect. It’s not necessary that rates fall at all, indeed interest rates usually RISE when monetary policy is highly expansionary.
1. March 2019 at 19:13
Scott, this is what Krugman asked-
“Are MMTers claiming, as Kelton seems to, that there is only one deficit level consistent with full employment, that there is no ability to substitute monetary for fiscal policy? Are they claiming that expansionary fiscal policy actually reduces interest rates? Yes or no answers, please, with explanations of how you got these answers and why the straightforward framework I laid out above is wrong.”
He wrote the questions. He picked out the words he wanted to use asking the questions. He wanted yes or no answers. And he got what MMT says in answer to his questions the way he wrote them and in the form he asked for. With explanations that fit in a newspaper column. What does he want- a special book written for him each time he asks a question? If he wants a book length treatment of not so simple questions then these are available on line and for free- he just needs to read them.
It would be a mistake to assume MMT economists like Stephanie Kelton do not understand ‘orthodox’ economic theory. And even a bit insulting. They are economists and got their educations in economics before MMT even existed as a category of economics.
1. March 2019 at 20:27
There seemed to be something lost in translation between Krugman and Kelton. I think part of the problem is that Kelton seems group under the label “deficit spending” both fiscal policy AND monetary policy. I.e. if the central bank increases the monetary base, Kelton calls that just another type of “deficit spending” not essentially different from the Treasury selling bonds and going further into debt. Because for her, there is no essential analytical difference between Treasury and Central Bank operations. The two are really part of a “consolidated balance sheet” of the entire government, kept apart for the moment by a contrived legal fiction (or “self-imposed constraint”) of Central Bank independence that might be dispensed with if there were the political will to do so.
Any time that Kelton talks about “deficit spending,” if you subsitute “fiscal+monetary expansion,” are there any essential ways in which her predictions would diverge from Krugman’s?
1. March 2019 at 21:50
Matthew:
“I.e. if the central bank increases the monetary base, Kelton calls that just another type of “deficit spending” not essentially different from the Treasury selling bonds and going further into debt.”
The Fed increases the monetary base by buying bonds, not selling them. It’s not the equivalent of the Treasury selling bonds. It’s the equivalent of the Treasury printing dollar bills without bothering to sell bonds.
1. March 2019 at 23:12
“MMT desperately needs a spokesperson capable of conversing with economists like Paul Krugman…”
When I read that Kelton op-ed (as well as this effort in the FT by a smattering of MMTers: https://ftalphaville.ft.com/2019/03/01/1551434402000/An-MMT-response-on-what-causes-inflation/), I felt that it was time to call the beginning of the end for MMT. Even a layperson such as myself can now see that the Emperor has no clothes; there’s simply nothing there beyond the verbal hocus-pocus. You read it here first!
2. March 2019 at 03:38
Krugman is making a correct point about the fact that other schools of economic thought recognize the need for fiscal engineering and/or monetary policy as the means to curb expected inflation. This is true even if one discounts his understanding of banking. So MMT is really opening a debate over the effectiveness of fiscal engineering versus financial engineering (banking policy and monetary policy) in historic contexts and prospectively for the future.
from another conversation at “Understanding Money”https://groups.google.com/forum/#!topic/UnderstandingMoney/AO3OppS_Z4E
2. March 2019 at 03:47
So relevant that no is really talking about to all of this…
Want to guess why more young people support socialism than capitalism? They cannot afford decent health care or their own place and have crushing student loans — all the while billionaires get tax breaks for their private jets. WTF do you think the outcome of that scenario is going to be?
Here is some advice to real capitalists: You best recognize that Socialism is the symptom, but the underlying problem is cronyism. Wise up before, as As Nick Haneuer presciently warned 5 years ago, The Pitchforks Are Coming… For the Plutocrats. https://ritholtz.com/2019/03/its-not-capitalism-its-crony-capitalism/
2. March 2019 at 06:30
Scott,
You said, ” She assumes that monetary policy works by encouraging borrowing. It doesn’t, it works by boosting NGDP through the hot potato effect. It’s not necessary that rates fall at all, indeed interest rates usually RISE when monetary policy is highly expansionary.”
You’re right and wrong. The transmission mechanism works by encouraging the non-banking sector to exchange financial assets for goods and service. This can happen either through lower rates or through higher NGDP expectations.
Monetary policy is NOT like a surplus apple crop, manna from heaven, or a helicopter drops. The transmission mechanism does NOT work through the hot potato effect.
2. March 2019 at 08:30
This excerpt from a recent post on 3P fleshes out what I meant by MMT’s word games getting lost in translation. I think this is one of the sources of disagreement between Krugman and MMT advocates:
“So they [MMT advocates] will say things like “taxes don’t fund spending” or things like “the answer to how will you pay for it is simply that you will spend the money” in discussions about, for instance, how to do welfare state expansions. Many people on the left read this and believe them to be saying that we can have a Nordic-style welfare state without increasing the US tax level. After all, if taxes don’t fund spending, then we don’t need them, right?
But that is not what they are saying. If you understand the MMT private language or have a couple of hours available to talk to an MMT advocate and slowly peel back the layers of obfuscation they like to use, you realize that “taxes don’t fund spending” is not saying we don’t need to raise taxes to expand the welfare state. Rather, it is saying that, in their idiosyncratic way of categorizing things, the necessary taxes do not “fund the welfare state,” but merely “offset the inflation caused by the money creation that funds the welfare state.”
This is a good way to jam up the discourse and confuse people, which can arguably be useful politically, but as a policy matter, it does not add any new insight. It tells you that the correct question is not “how will you pay for this” but rather “how will you offset the inflation that is caused by paying for this with created money since all government spending is created money.” Nonetheless the rephrased question has the same answer as the first one: some combination of taxes and borrowing that will eventually have to be worked out.”
The other pillar of disagreement between Krugman and MMT advocates seems to me to be the MMT assumption that no new taxes will be needed in order to curb inflation until full employment is reached. I.e. up to that point of full employment, you can indeed expand the welfare state with a job guarantee or whatever and “get a free lunch” by using those currently unused excess labor and capital supplies, so i.e. you need not worry about inflation or raising new taxes in order to counter-act that inflation until full employment is reached. In other words, the assumption that significant inflation is impossible to have alongside significant unemployment. This seems to be empirically false, full-stop. Of course, the MMT advocates will claim special circumstances in each case where this has historically been false (1970s, 2009, etc.). What epicycle will they add onto their theory the next time inflation and unemployment break out at the same time?
2. March 2019 at 09:25
Scott,
MMT is such a mess. I feel for you man. Here’s a link from July 28, 2011:
https://www.themoneyillusion.com/where-mmt-went-wrong/
Groundhog Day amirite?
It may be useful to reflect on the insurgent freshwater voodoo economics from 1980. Those guys had a lot of intellectual firepower and cogent thought behind them. Who are the leading lights in the MMT constellation? I can’t believe anyone worth taking serious is out there, because the whole thing is so willfully stupid.
So… what are the chances any of this gets any traction? Won’t economists of almost all stripes join the chorus against MMT?
2. March 2019 at 10:47
Benjamin Cole,
I like the way you juxtapose Martin Feldstein’s impressive “macroeconomic credentials” with his total failure to predict interest rates and inflation for the last ten years. I gave up reading Feldstein’s articles YEARS ago (except when in search of a laugh).
Scott,
You accuse Kelton of (wrongly) assuming that monetary policy (by which I assume you mean interest rate cuts) work via increased investment. Well I agree with Kelton that interest rate adjustments are not a brilliant tool for adjusting demand, but it’s going a bit far to say they have no effect at all surely? Any business contemplating borrowing so as to fund an investment, and which sees interest rates decline will be encouraged to go ahead with the loan and investment won’t it?
Jerry Brown,
Thanks for clarifying exactly what Krugman was asking, because it wasn’t clear to me from Scott’s above article exactly what “Krugman question” Scott was concerned about.
Rajat,
There’s a slight flaw in your dismissing MMT because of that Financial Times article, which is that the allegedly MMT ideas demolished there are not MMT ideas, far as I know. I must have read a thousand articles by MMTers over the last ten years, but I’ve never before come across the idea put by Fulwiller & Co and cited in the FT article to the effect that better control of cartels and drug prices can counter inflation.
Of course it’s clearly a truism that inflation CAN BE countered to some extent that way, but the flaw in that “Fulwiller” argument is that the “cartel/drug price” sort of problem is one that we ought to attend to ANYWAY, i.e. regardless of whether MMT is implemented or not. Indeed it already is being attended to in that most governments have anti monopoly and anti cartel legislation in place. In short, the “cartel/drug price” point is irrelevant to the arguments for and against MMT.
2. March 2019 at 11:13
Jerry, You don’t find it odd that she says “no” and then provides an explanation that suggests she clearly thinks the answer is “yes”?
You said:
“It would be a mistake to assume MMT economists like Stephanie Kelton do not understand ‘orthodox’ economic theory.”
I’m not a mind reader, all I can say is that she writes in such a way as to make it seem to me (and to Krugman) that she doesn’t understand the theory. She continually misrepresents what mainstream theory says.
Matthew, You said:
“Any time that Kelton talks about “deficit spending,” if you substitute “fiscal+monetary expansion,” are there any essential ways in which her predictions would diverge from Krugman’s?”
That doesn’t rescue her claims, as Krugman specifically asked about the effects of substituting monetary and fiscal policy.
You said:
“I.e. if the central bank increases the monetary base, Kelton calls that just another type of “deficit spending” not essentially different from the Treasury selling bonds and going further into debt.”
You are not allowed to make false statements, and then wave it away by saying “that’s my assumption.” Increasing the base is not deficit spending, not if the new base money is used to buy back T-securities. (I’m not sure that is her claim, BTW.)
Ralph, So why is investment usually lower when interest rates are lower? Again, don’t reason from a price change.
2. March 2019 at 14:48
Unfortunately, I find this part of Krugman’s response strange as well:
“She asserts that interest rates don’t matter for demand by citing small effects on business investment — a point I’ve also made. But monetary policy works through housing and the exchange rate, which every macroeconomist know”
In the US, the monetary policy framework for 1971-2008 was to have zero-yielding reserves and T-bills earning above 0%. The monetary policy transmission mechanism is obvious. If the Fed prints more money and the money yields zero, private individuals will spend that money immediately. Why all the indirection about interest rates?
Interest on reserves changed this simple mechanism. $2 trillion of excess reserve exist today because the reserves yield T-bill rates. However, the Fed still has an obvious control mechanism for NGDP. It can change IOR. If IOR hits zero, then the Fed can fall back on the 1971-2008 mechanism for increasing demand.
Things are different at the zero-bound, but we are not at the zero-bound. Why did Krugman confuse the issue so much?
2. March 2019 at 17:14
MMT…
You know, the MMT crowd does make some interesting points.
If you wish to stimulate economy would it not make sense to, say, give $1000 to every person in the lower quadrant of income— low income people would tend to spend the money.
The monetary approach, that of lowering interest rates or conducting QE does seem a bit claptrappy and Rube Goldberg-ish, although worth doing. You are hoping for endogenous money creation and for a hot potato effect (how much of a hot potato effect can be generated when capital markets are global is another interesting question). Paul Krugman says monetary policy works through housing markets and exchange rates, which is another puzzling aspect—-I assume a cheaper dollar means more exports and less imports, and thus a boost to gross national income. America First?
I think where the MMT crowd makes a mistake is they advocate more government spending, rather than automatic tax cuts, say whenever unemployment tops 4%.
Like many people, I am dubious about federal government spending including that for national security.
The MMT crowd would get more traction if they would simply advocate cuts in Social Security payroll taxes offset by QE-financed contributions to the Social Security fund, whenever unemployment tops 4%.
2. March 2019 at 17:25
Matthew, That’s how Keynesians describe the transmission mechanism. I don’t like it either.
2. March 2019 at 21:28
“The monetary approach, that of lowering interest rates or conducting QE does seem a bit claptrappy and Rube Goldberg-ish, although worth doing.”
See my comment above. All this other stuff (interest rates, IS-LM, etc.) are FAR more confusing than “Print more money to buy bonds. The seller probably wants to do something with the money.”
The two caveats are the zero-bound and IOR. IOR is a monster of the Fed’s own creation and they can destroy it if needed to raise NGDP.
For the zero-bound, the Fed left trillions of dollars of positive yielding Treasuries on the table in 2008. I do think a theoretical emergency back-stop is needed past buying Treasuries though. I favor helicopter money tax cuts, as Bernanke proposed for Japan. Private asset QE is an option, but I morally disdain public money buying wholesale private assets.
The zero-bound tax cut may not be needed at all or may be small. However, I would want QE and the tax cut to be used instead of all section 13(3) bailouts in 2008. If Bear was allowed to fail in 2008 and absolutely no bailouts happened, I could see the Fed actually exhausting its bond-buying ability, at least slightly. So I want the backstop to be unlimited to remove any justification for bailouts.
The system could also allow the abolition of deposit insurance and discount window, with the Federal government only guaranteeing 100% reserve accounts. That’s a far bigger bridge to cross though.
4. March 2019 at 06:14
Can I assume that both sides are understanding comparative statics?